Procedure & Administration
The IRS announced it will not follow the decision in International Business Machines Corp., 343 F.2d 914 (Ct. Cl. 1965), in which the Court of Claims held that the IRS could only apply an adverse ruling prospectively if applying it retroactively would treat the taxpayer who requested the ruling differently from a taxpayer who received a favorable ruling on the same subject.Background
In April 1955, the IRS ruled that certain computer systems sold by a competitor of International Business Machines (IBM) were not subject to an excise tax on business machines and issued a refund of the excise tax for the three previous years. Three years later, the IRS revoked the earlier favorable ruling but made the revocation prospective. This resulted in a six-year period from January 1952 to January 1958 during which the competitor was not subject to the excise tax.
In July 1955, IBM requested the same ruling from the IRS with respect to computer systems it sold and filed a claim for refund of taxes paid in June 1951 through May 1955. After more than a two-year delay, in November 1957, the IRS issued a ruling that IBM’s computers were subject to the excise tax. IBM subsequently filed a refund request for the period June 1955 to January 1958, making the period for which it requested refunds approximately equal to the period for which the competitor was not subject to the tax. The IRS denied both of IBM’s refund requests, and IBM filed a refund suit in the Court of Claims.
The Court of Claims held in favor of IBM, finding that the IRS had improperly applied its November 1957 ruling to IBM retroactively (refusing refunds back to 1951). Citing Automobile Club of Michigan, 353 U.S. 180 (1957), the court found that it was an abuse of discretion for the IRS to apply a ruling retroactively if doing so would produce inequitable results. According to the court, IBM “was entitled to have the Service’s ruling . . . controlled by the standard of equality and fairness incorporated in Section 7805(b).” Finding that in this case an inequitable result had occurred as a result of the IRS’s retroactively applying the ruling, the court concluded that the IRS had abused its discretion in doing so.
In Action on Decision (AOD) 2012-02, the IRS announced that it will not follow the decision in International Business Machines Corp. Although the announcement comes 47 years after the Court of Claims decided the case, the IRS averred in the AOD that it has never agreed with the holding. Besides not following the decision with respect to the retroactivity of rulings, the IRS also stated that it will not follow the case on the larger issue of determining whether a taxpayer is entitled to a particular tax treatment because of a claim of disparity with respect to an allegedly similarly situated taxpayer, whether or not the taxpayers applied for or received rulings on their respective positions.
Besides referring to a laundry list of cases where it claimed a court had not followed the holding in IBM, the IRS identified two specific reasons that it should not follow the decision. First, the IRS pointed out that if principles of equity required it to apply an error it made with respect to one taxpayer to every similarly situated taxpayer, Congress would no longer determine who is liable for tax. In addition, allowing certain taxpayers the benefit of an error might not lead to an overall fair result, because other taxpayers who lacked the means to find a “similarly situated” taxpayer who had escaped the tax would find the entire tax burden unjustly falling on them.
The IRS also quoted the Third Circuit’s opinion in Merck & Co., 652 F.3d 475 (3d Cir. 2011), to support its position. In that opinion, the Third Circuit argued that an IRS error should not effectively nullify a provision of the Code for all other taxpayers. It also contended that, due to the ever-changing efforts to evade taxation, it is necessary that the IRS be allowed to pursue later tax evaders even if it mistakenly allows an earlier taxpayer to use a tax-evasion scheme. The court further stated that if taxpayers routinely were allowed to challenge tax assessments on the grounds that similarly situated taxpayers had avoided tax, the flood of litigation on the issue would prevent the IRS from being able to focus on whether taxpayers had complied with the law.
The IRS is correct in its refusal to follow the decision in IBM. The Court of Claims, having no basis in the law for granting IBM relief, concocted a dubious argument about the existence of a standard of fairness and equity in Sec. 7805(b) to provide relief. The IRS’s discretion to limit retroactive application of any ruling, regulation, or decision is designed to protect taxpayers who have acted to their detriment in relying on those prior rulings. The later-revoked, erroneous ruling issued to the competitor was a private letter ruling that covered only the competitor’s machines, designated by name and number; IBM could not show that it relied on the letter ruling or that it suffered any competitive disadvantage because of the ruling.
As the dissent in the case explained, while IBM may have suffered damages as result of the IRS’s incompetent treatment of its ruling request, the relief it sought should have come through a legislative provision providing for damages in such instances, not by a remission of taxes that were lawfully due.
Action on Decision 2012-02 (9/12/12)